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Comment by CSSer | Hacker News Reader

Institutional investors. I can’t explain it better than Matt Levine’s article. It’s well worth the read, and it links directly to the SEC proposal if you’d like to read deeper from there.

After reading the article, my take is less harsh. It is really bizarre to me why instead of outright banning it, they just want to make it a really bad deal to do so. But if it works, great! We’ll see.

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Levine doesn't believe PFOF involves people skimming money from retail investors, if that's what you're implying. Levine's story boils down to: retail order flow is cheaper to make markets for, wholesalers and brokers can split the savings three ways (between retail investors, the broker [via PFOF], and the wholesaler). That's not skimming; that's, like, the operating principle of Walmart.

There's an argument that it artificially increases spreads in lit markets, since you have segregated the least toxic flow to only go to a few select players (largely Citadel and Virtu). Further, these increased spreads mean that the 'price improvement' is only price-improved against a spread that's being quoted against only the most toxic flow. However, many spreads are still close to a single tick, although this is less true as individual ticker prices have generally gotten higher.

The tick size changes are interesting as well in the context of auctions. If a claim is "you can't have an auction with sub-penny pricing so there's no improvement", well then make the tick size smaller.

Another argument against PFOF is that brokers could (and Robinhood has been caught doing it) be incentivized to route orders to the highest PFOF rather than executing at the best real price.

As a retail investor, I’d rather have PFOF and free trading instead of paying $5 to $10 a trade which is more expensive than spread improvements.

That’s what PFOF has brought to retail investors. It’s not like retail investors was ever put onto the public exchanges prior to robinhood and PFOF, they were sent to dark pools for institutional investors to trade against but retail investor never got the benefit.

PFOF isn't gigantic revenue driver for many retail brokerages, including some that offer zero commission trading (like Schwab). Robinhood may have started the price war while making most of its money from PFOF, but you can have low to zero commission trading without PFOF.

The payments per share tend to be extremely small - on most symbols the broker isn't making $5-10 per trade from the MM, for reasonably sized trades.

Even if payment for flow was costing you that much, paying for an order vs giving more price improvement are indistinguishable. Payment for order flow just means that price improvement definitely goes to the broker instead of back to you.

Robinhood forced the discount brokers to adopt zero commissions. Robinhood only exists because of PFOF. Being on Schwab you indirectly benefited from PFOF and Robinhood because you don’t pay commissions. I personally don’t use Robinhood but I recognize that they have been beneficial to me.

Matt Levine:

> The customers think they have no cause for complaint, because they did better than the NBBO. The whole thing is an institutional equivalent of retail payment for order flow: The partner firms fill the customers at a better price than the NBBO, make some profit for themselves, and kick back some of it to the broker (Coda).

https://www.bloomberg.com/news/newsletters/2021-09-23/money-...

Where is the money skimmed from the retail investor there? They beat the NBBO?

Levine is entitled to his opinion, but I don't think he has argued that retail investors receive better prices compared to a condition where all of their orders are sent to lit venues and makers who want retail flow have to get it by having top-of-book (or midpoint peg or whatever) orders at lit venues.

It's not so much his opinion as the law. Wholesalers have to improve the lit market price, or else route the order to the lit market. And it's clear how they're able to improve that price! The lit market has to serve institutional traders, who are much more expensive to trade against.

The law obviously does not say anything about price improvement compared to counterfactuals either.

Are you saying that if makers' profitability at lit venues was greatly improved, they wouldn't compete to offer tighter spreads at all?

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